Hidden Costs of Home Ownership (Maintenance Costs) © Dr. B. C. Paul 2002 revisions 2008 Note – The subject covered in these slides is considered to be “common knowledge” to those familiar with the subject and books or articles covering the concepts are widespread.

Maintenance Costs  Home owners have regular repair costs  DeSoto house needs some initial repairs  about $5,000 for materials plus some personal “sweat equity”  Herby could get a personal loan from Old Rational bank for 5 years at 10% interest with a $200 loan application fee  Herby could get a simple interest loan from Sleezy Money Financial for 9% with no application fee  Herby’s could just use his credit card at 13% interest  There are routine things that break down - Herby figures about $75/month

Herby’s Big Kicker  Herby is getting the house pretty cheap but  The roof will probably fail in 4 years  This will likely cost about $4,200  Herby is concerned about whether he will be able to get additional money on loans at a critical time like that.

How Should Herby Deal With This?  $75/month maintenance is just an annuity in the cash flow.  The loan vs. credit card choice is another of those spreadsheet comparison jobs  Figure the cash flow from each  Pick a preferred alternative  Subtract one alternative from the other to define a cash flow of costs and benefits from choosing your favorite  Discount cash flow back and see if your preferred alternative saved you enough.

The Roof  Herby sees a big expense coming and can’t risk ability to get credit when it hits  Answer is a business device called a sinking fund  Save up money just like Fursee Foresight  Money is saved up as a series of regular savings at the end of each compounding period - ie. Its an annuity.

The Sinking Fund  Discounted Cash Flow was developed in Mining  Got its name from the practice of saving money to sink a new mine shaft  Trick here is that we are trying to find an annuity that will reach a set amount of money at some time in the future  P/A and A/P deal with present values  F/A converts and annuity to a future value

Enter a New Super Hero  A/F  Check to make sure she can do the job  A/F * Future Cost of Re-roofing  Need to know n  re-roof in 4 years (but we’re on a monthly schedule)  4*12 = 48  Need to know i  What ever Herby can get on his savings

Herby Builds a Sinking Fund for His Roof  Herby will put money into a money market account at 5% interest (compounded monthly)  Using the formula  Just F/A flipped  ( i / {[1 + i ] n -1}) = A/F  for i= 0.05 /12 =  and n=48  A/F =

Herby’s Monthly Cost for the Roof  * $4,200 = $79.22  Herby now has monthly maintenance costs of  $75/month routine maintenance  $79.22/month sinking fund to replace the roof  Herby still needs to deal with the $5,000 in initial repairs